Universal Healthcare: A Win For Health Insurers?

By Kristina Zucchi, CFA | January 18, 2010 AAA

The election of Republican Scott Brown of Massachusetts adds a new layer of uncertainty to President Obama's push for universal health coverage for all Americans. Tipping the balance of power from the democratically controlled Congress and allowing the Republicans filibuster power may prove to be the single most important influence on the final health care bill. However, if a bill is passed that is similar to the Senate health bill, the health insurance industry will be negatively impacted. (For related reading, check out Intro To Insurance: Health Insurance.)

There are an estimated over 40 million uninsured Americans today and the bill would increase coverage to about 29 million uninsured. The Council of Economic Advisers for President Obama reports that the average annual premium for individuals is over $4,000 creating more than $116 billion in new premium revenue. And the bill provides strong incentive for these uninsured to buy insurance via inflicting penalties for those who do not buy. That's where the good news ends.

Capping the Medical Loss Ratio
The health insurance industry is a for-profit industry. The large insurers, United Health Group (NYSE:UNH), Aetna (NYSE:AET), Wellpoint (NYSE:WLP) and Cigna (NYSE:CI), are all publically-traded companies.

Health insurers make money when the spread between medical costs and premiums is wide. According to the companies, through cost controls, higher quality of care and health initiative programs to promote wellness, medical costs are able to be controlled, thus providing better quality of care while raising profitability for the insurers.

Health insurance companies measure the success of these initiatives by calculating a medical loss ratio (or medical benefit ratio). The medical loss ratio is the ratio insurance companies and analysts use to determine profitability, similar to the profit margin ratio used by other industries. It is defined as the amount spent on medical care out of the premiums (revenue).

The companies increase profits and earnings per share as the medical loss ratio improves. The Senate bill tries to cap the medical loss ratio by provisioning that $0.85 out of every dollar needs to be spent on medical care. That means that $0.15 of every dollar is left over to pay for non-medical expenses and for profit; a big change for an industry where it is not uncommon to have medical loss ratios averaging between 77-81% for most of the big players.

Investors do not like to invest in businesses with virtually no ability to improve profits - something this bill attempts to achieve with the medical loss ratio requirements. (For more, check out Investing In Health Insurance Companies.)

Insuring the Undesirables
Health insurance is based on actuarial assumptions - formulas used to determine if the premiums charged are sufficient to cover the potential medical costs. These formulas are based in part on a member's medical history and the presence of pre-existing conditions. The Senate bill proposes banning the denial of coverage due to pre-existing conditions. Additionally, it restricts the insurers from placing lifetime limits on benefits. Both of these components will negatively impact the profitability of the insurer. (For more, see Health Insurance: Paying For Pre-Existing Conditions.)

The Bottom Line
Investing in an industry heavily tied to changes in government spending means headline risk is extremely high. Health insurers' profitability with universal health coverage and Medicare becomes even more influenced by changes in government policies. The election of a Republican in a Democratic state who campaigned against government controlled health care put a monkey wrench in President Obama's quest for universal health coverage. As such, the Senate bill passed may undergo significant changes. Therefore, if and when a final health care bill gets passed and if it resembles the components of the Senate bill aforementioned, the impact to the health insurers stock will be negative.

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